US Tariffs and their effects on Emerging Market Debt

24
April
2018

By Mike Hugman, Portfolio manager

Mike Hugman, Emerging Markets Fixed Income Portfolio Manager, argues that this round of actions is now largely announced and reflected in markets and will create opportunities to add risk to portfolios via EM currencies and equities in coming weeks.

Opportunities amid volatility

In recent weeks, the US administration has acted on 2016 election promises to put America first in global trade policy. This has taken two forms – global metals tariffs, and China-specific tariffs relating to technology intellectual property theft. Our baseline is that this will not start a reciprocal trade war, and hence have limited medium-term impact on global growth and markets. A further sell off in risk assets may provide opportunities for investors to add risk. Our asset allocation preferences are emerging market currencies and equities.

Metals tariffs not a major medium-term risk

Global metals tariffs were enacted under section 232 of the 1962 US Trade Expansion Act, citing the need to protect domestic steel production to ensure long-term self-sufficiency and hence national security. The US imported around 36 million tonnes of steel last year, and 6 million tonnes of aluminium, worth around US$40bn. Tariffs proposed were 25% and 10% respectively, representing a small fraction of the value of global trade in those metals. Additionally, the US has granted short-term exemptions to Canada, Mexico, the EU, Australia, South Korea, Argentina and Brazil, which account for about 75-80% of those imports. We expect deals to be reached exempting many kinds of specialist steels, as US industry ex-steel is lobbying hard against these measures. Thus this set of tariffs are not a major medium-term risk.

The case of China

US Trade Representative Lighthizer has been investigating Chinese extraction of US intellectual property under section 301 of the 1977 US Trade Act. Independent estimates have put the long-term cost to the US economy in the range of US$200-400bn. Yesterday, President Trump announced tariffs averaging 25% on a list of goods worth up to $50bn in exports to the US. The final list of goods is yet to be announced, but will come within 15 days, with a 30-day consultation period. The net amount, US$12.5bn, would take around 0.1% off Chinese GDP.

China has responded with mixed rhetoric. A conciliatory speech earlier in the week from Premier Li acknowledging the need to reduce the barriers to foreign investment in China and to end technology transfer demands, reassured markets. This morning, China has announced tariffs of 10-25% on US$3bn worth of US agricultural imports in response to the original section 232 metals tariffs. The announcement carried a stronger tone, warning the US against further actions.

Our base case: largely in the price

The current level of US tariffs, and the response from China, have both been smaller than we expected, given prior analysis. We do not see this as an incentive for China to escalate this trade conflict given the success of ongoing domestic economic reforms, while the US administration has achieved its PR goals. Our base case is therefore that this round of actions is now largely announced and reflected in markets.

In anticipation of this risk weighing on markets in the short term, earlier in the quarter we reduced emerging market currency exposure in our emerging market debt strategies, and equity risk in the emerging market multi asset strategy. However, in our base case of these trade actions remaining contained as outlined above, this will likely create opportunities to add risk to portfolios in those areas in coming weeks.